SaaS (software as a service) businesses that don't want to process payments or manage sales tax and VAT (value-added tax) compliance on their own can opt to outsource many of these obligations to a merchant of record (MoR).
When you work with a MoR, it becomes the legal entity that officially sells your product to consumers. Your company still delivers the software, but your business doesn't have to manage the logistics of processing payments, fighting fraud, responding to chargebacks, staying current on tax laws, or collecting and remitting sales tax and VAT.
Handing off those obligations to a MoR can make expanding into new markets much simpler and can significantly reduce your compliance burden and exposure to tax and payment-related liability. But it also means giving up parts of the customer experience, which can have a negative impact on brand cohesion.
This guide will explain how partnering with a MoR works, list some of the important benefits and drawbacks of such an arrangement, and offer some tips on when to choose a MoR and when to look at alternatives.
What does working with a merchant of record look like for SaaS companies?
Working with a MoR is different for SaaS companies than for many other e-commerce businesses.
While a typical e-commerce seller sells a product and processes a payment once, a SaaS business forms an ongoing relationship with customers, because those customers have to continue paying subscription costs to keep accessing the software, whether the payments are made monthly, annually, or on some other schedule.
And each of these transactions raises questions such as:
- What's the best way to process the payment?
- Is this transaction subject to sales tax or VAT?
- What tax rate should be charged?
- How can the company prevent fraud?
- How are mid-cycle adjustments handled quickly while accounting for any usage credits?
- What if the customer needs a refund?
All of these questions, and more, can be answered by a MoR, because it acts as the official seller.
The MoR:
- Handles payment processing, fraud prevention, and chargebacks.
- Keeps up with the evolving rules on whether SaaS is taxable in different areas where buyers are located.
- Calculates the correct tax rate.
- Addresses complexities raised in situations where only some components of a bundled transaction are taxable.
- Collects taxes.
- Registers with revenue departments.
- Files tax forms.
- Remits collected tax amounts to the correct authorities.
An MoR may even offer enterprise-grade subscription management capabilities, including automatically pro-rating payments for mid-cycle changes and applying configurable billing logic if your pricing model is usage-based.
Why SaaS payments are complex
While any business can partner with a MoR, this relationship can be especially beneficial for SaaS companies because of the complexities of the SaaS business model, such as:
- Offering SaaS can make you more vulnerable to chargebacks and disputes: Customers may file chargebacks retroactively if they forget to cancel subscriptions or if they don't want to deal with the hassle of trying to cancel. Because your product is intangible, it can also be harder to provide proof of delivery.
- SaaS billing is complex: Your company must charge customers every time their subscription renews, creating more chances for payment processing issues. You may also have complicated pricing structures, such as a hybrid structure that includes a usage allowance and charges for overages. In addition, some SaaS companies offer multiple products requiring different billing modalities; country-specific pricing; or custom pricing.
- SaaS companies often sell across borders: If you sell software in multiple states and countries, you must track sales in each one to determine when you establish economic nexus. And many countries have no VAT registration threshold for non-resident digital service providers, so you must register from the first sale there. The more locations you do business in, the more difficult complying with tax obligations becomes.
- The taxability of SaaS varies widely: Some states and countries tax SaaS, some don’t, and some tax certain kinds or in certain situations. Tax rules are also evolving as lawmakers grapple with changes to the way software is delivered. This makes it more complicated to determine when you need to charge your customers tax.
If you don’t have a MoR, you need to have systems and processes in place for addressing all of these issues. When you’re expanding quickly, or when you're a startup without in-house legal, finance, or compliance teams, this can slow down your growth, add costs, or be difficult to achieve.
Benefits of using a merchant of record
There are some obvious benefits of using a MoR as a SaaS company. Here are some of the biggest:
- Your MoR can offer local payment options: A MoR can accept the types of payments that are common in different countries, making it easier for customers to check out and increasing the chances of sales.
- Your MoR typically assumes liability for fraud, chargebacks, and payment disputes: Actual liability allocation may depend on your agreement.
- Your MoR handles global tax compliance: Most full-scale MoRs are registered across multiple countries, and they handle global tax compliance for you. The MoR collects the correct amount of tax, files forms, and remits payments, saving you from all of the obligations associated with sales tax or VAT requirements.
- Your MoR simplifies invoicing and legal compliance: Your MoR makes sure you comply with payment processing rules and send invoices that comply with legal requirements, including under the European Union’s (EU’s) reverse charge mechanism for B2B sales.
- You can expand faster: In many cases, you won’t need to register for VAT or establish local tax registrations before selling in new markets, though other regulatory or business requirements may still apply. This lets you move into new markets faster.
Tradeoffs and limitations
There are also some significant downsides to using a MoR, including:
- MoR fees can be high: A MoR typically charges between 2.5% and 8% of all transactions. This is a high percentage, and since your transactions are recurring, you'll have to pay this percentage of every sale. The cost also doesn't necessarily go down as you scale, unlike many other operational expenses.
- Loss of direct control over the billing and subscription experience: With a MoR, you won’t control the customer's experience throughout the transaction; the MoR takes responsibility for a significant portion of your customer service, including resolving payment disputes. This can affect perceptions of your company if the MoR imposes different policies than you would prefer. It also limits your ability to be flexible with pricing or billing.
- Fewer opportunities to customize the customer experience: MoRs may provide limited options for complex billing and payment models, such as usage-based billing, discounted prices for enterprise customers, splitting costs among different departments, or offering multi-user accounts. MoRs that offer this level of customization may charge higher fees.
- You could weaken your brand identity: The MoR's name will appear on invoices and on your customer's credit card or bank statements. This can create confusion and weaken your brand identity.
- Cash flow timing can create issues: Payments must pass through the MoR, and this can lead to delays that affect your cash flow. While you’ll usually have the funds in a day or two with direct payments, the MoR could hold funds for weeks or even months, affecting your operations and ability to grow.
- You'll lose control over your customer data: The MoR may provide you with some data about your customers, but you may not have access to everything you need to run granular analytics and make strategic decisions guided by data.
- Integrating your MoR with in-house systems can be challenging: Integration may require complex API synchronization, and there could be data-formatting mismatches. This creates a risk of broken workflows and could burden your engineering team with managing these issues instead of developing your core product.
- There's a lock-in problem: Once you have begun working with a MoR, your MoR has your customer data and is in control of your payment processing. Ending the relationship could require all of your customers to migrate to new payment methods for recurring subscriptions.
When SaaS companies should use a merchant of record
With these big pros and big cons, it can be hard to figure out when it actually makes sense for your SaaS company to use a MoR. Here are a few key circumstances when it may be a good fit and when it may be the wrong choice.
When it’s a good fit
Working with a MoR may make sense for SaaS startups in a few key situations:
- Early-stage SaaS companies with limited finance and legal staff: If you are a lean startup without finance or legal staff, figuring out how to manage compliance with payment processing rules, sales tax, and VAT can be burdensome or impossible. Outsourcing to a MoR may be more cost-effective than building entire departments to handle these tasks, or risking fines and penalties for not following the rules.
- SaaS companies selling in many global markets: The more markets you sell in, the more complex complying with tax obligations becomes. You may need dozens of registrations, often with local fiscal representatives, and you will need to keep track of varying tax rules across multiple locations.
- SaaS companies lacking subscription infrastructure: Setting up the infrastructure to collect recurring payments for subscriptions can be burdensome and difficult if you don't outsource to a MoR.
When it’s not a good fit
There are also times when it doesn't make sense for your company to work with a MoR:
- You have complex enterprise billing processes: Many MoRs operate with standard payment models and aren't equipped to handle complex billing structures.
- Your company wants full control over data, branding, or customer experience: If you don't want to outsource the payment process or if you want to ensure you have full access to all sales data surrounding subscriptions and payments, working with a MoR isn’t right for you.
- You have an in-house finance and/or legal department: Working with a MoR when you have your own in-house teams may result in duplicated efforts and added costs.
Tax without an MoR
If you don’t partner with a MoR, you will need to manage tax and subscription compliance on your own. This means you must understand certain key requirements:
- VAT for digital services: Many countries charge VAT on digital services, including EU countries, the UK, and many ASEAN countries. Many countries also have no VAT registration thresholds, which means that you must register for VAT upon your first taxable sale. (For which you may need a fiscal representative.) You'll also have to make sure that you're sending VAT-compliant invoices, keep required records, file VAT forms, and remit taxes as required. You need to understand and comply with all of these registration and VAT collection requirements if you plan to offer your software subscriptions globally.
- Sales tax: Throughout the U.S., some but not all states tax SaaS. You need to know which states charge sales tax, track when you have established economic or physical nexus, and register in states once you’ve done so. You'll also need to charge tax at the correct rate, file on schedule, remit taxes as required, keep track of exemptions, and remain audit-ready.
Managing these obligations can be a heavy lift for smaller companies that don’t outsource to partners.
Final thoughts
Working with a MoR can make it easy to expand globally quickly and can relieve your SaaS company of a lot of compliance tasks and legal risks, but it also means limiting your payment options, giving up customer data, losing some of your brand identity, and creating a relationship that it can be difficult to get out of.
Popular MoRs include companies like Paddle and FastSpring.
You should think carefully about the pros and cons, as well as alternative options to working with a MoR.
Other compliance support options include companies like Numeral, which manages sales tax and VAT compliance across 70 countries and can help make these processes effortless. In fact, with Numeral, you can fulfill your tax obligations in as little as five minutes per month.
